Equity Valuation

sanbiz20
Finance Junkie
Posts: 53
Joined: Sat Apr 01, 2017 2:12 pm

Equity Valuation

Postby sanbiz20 » Mon Sep 18, 2017 6:29 am

Q. An investor is considering the purchase of a common stock with a $3.00 annual dividend.
The dividend is expected to grow at a rate of 3 percent annually. If the investor’s required
rate of return is 12 percent, the intrinsic value of the stock is closest to:
A. $33.33.
B. $34.33.
C. $30.00.

In this question I am unable to make out whether the annual dividend is the dividend paid out in the last year or will be paid at the end of current year. Kindly clarify how to solve such kind of question.

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edupristine
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Posts: 890
Joined: Wed Apr 09, 2014 6:28 am

Re: Equity Valuation

Postby edupristine » Mon Sep 25, 2017 9:21 am

The problem is related with 'Dividend Growth model'.

Annual dividend given in the question is referred to the dividend paid by the company in given year, (since it is not mention anywhere in the question that this dividend will be paid in next year) and such dividend will grow @ 3% for the coming year.

IV= DPS (1+g%)/ ke-g%

DPS = $3

g = 3%

Ke = 12%

IV = 3(1+1.03)/12%-3%
= $34.33

sanbiz20
Finance Junkie
Posts: 53
Joined: Sat Apr 01, 2017 2:12 pm

Re: Equity Valuation

Postby sanbiz20 » Tue Sep 26, 2017 4:19 am

Does it imply that if not stated in the question about the timing of dividend paid; we should assume that the dividend was paid in the last account period and not the dividend that will be paid out in the future.

edupristine
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Posts: 890
Joined: Wed Apr 09, 2014 6:28 am

Re: Equity Valuation

Postby edupristine » Tue Sep 26, 2017 8:23 am

If the dividend is for the next year that it will specify clearly like in below cited example:
Q- Using the constant DDM model, what must be the growth rate of a stock that is selling for $50, has a cost of capital of 12%, and whose dividend next year is expected to be $2?
Value = D1/(k-g), solving for g, we have g = (Value(k) – D1)/Value. So g = (50(.12) – 2)/50 = .08.

But if it is for the current year than it will state like in below mentioned ques:

Q-An investor is considering the purchase of a common stock with a $2.00 annual dividend. The dividend is expected to grow at a rate of 4 percent annually. If the investor’s required rate of return is 7 percent, the intrinsic value of the stock is closest to:
A.$50.00.
B.$66.67.
C.$69.33.

Correct ans is C.


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